What is a Letter of Credit?

A letter of credit is a banking mechanism which allows importers to offer secure terms to exporters.

All letters of credit contain these elements:

* a payment undertaking given by the bank (issuing bank)
* on behalf of the buyer (applicant)
* to pay a seller (beneficiary)
* a given amount of money
* on presentation of specified documents representing the supply of goods
* within specific time limits
* these documents conforming to terms and conditions set out in the letter of credit
* documents to be presented at a specified place.

Put simply, the issuing bank's role is twofold:

* to guarantee to the seller that if compliant documents are presented, the bank will pay the seller the amount due. This offers security to the seller - the bank says in effect "We will pay you if you present documents (XYZ)"

* to examine the documents, and only pay if these comply with the terms and conditions set out in the letter of credit. This protects the buyer's interests - the bank says "We will only pay your supplier on your behalf if they present documents (XYZ) that you have asked for"

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Note that the letter of credit refers to documents representing the goods - not the goods themselves! Banks are not in the business of examining goods on behalf of their customers
Typically the documents requested will include a commercial invoice, a transport document such as a bill of lading or airway bill, an insurance document; but there are many others.

Letters of credit deal in documents, not goods.

What are the stages of the Letter of Credit? We shall see this in our next post..